Multiple Choice Questions: How To Value Bonds and Stocks

Chapter 06 - How to Value Bonds and Stocks
Chapter 06
How to Value Bonds and Stocks
Multiple Choice Questions

1. A pure discount bond:

A. has no face value.
B. pays interest annually.
C. pays interest semiannually.
D. pays no coupon.
Accessibility: Keyboard Navigation

Blooms: Remember
Difficulty: Easy
Topic: 06-02 How to Value Bonds

2. A level coupon bond:

A. pays the same principal every period.
B. pays the same taxes every period.
C. is a zero-coupon annuity.
D. is an annuity over the life of the bond.

Blooms: Remember
Difficulty: Easy

6-1
3. The coupon of a bond is:

A. its time period to maturity.
B. its current price.
C. its face value.
D. its yield to maturity.
E. the amount of the interest payment.

Blooms: Remember
Difficulty: Easy
Topic: 06-01 Definition and Example of a Bond

4. Consider a bond which pays 7% semi-annually and has 8 years to maturity. The market
requires an interest rate of 8% on bonds of this risk. What is this bond's price?
A. $942.50
B. $911.52
C. $941.74
D. $1064.81

Blooms: Analyze
Difficulty: Medium

5. Gugenheim, Inc. offers a 7% coupon bond with annual payments. The yield to maturity is
5.85% and the maturity date is 9 years. What is the market price of a $1,000 face value bond?
A. $742.66
B. $868.67
C. $869.67
D. $1,078.73
E. $1,079.59

Blooms: Analyze
Difficulty: Easy

6-2
6. A consol:
A. always sells at a premium.
B. always sells at a discount.
C. is an agent that makes interest payments.
D. has no maturity.
E. pays no interest.

Blooms: Remember
Difficulty: Easy

7. A bond is listed in the Financial Post as a 8.800 of September 22/25. This bonds pays:
A. $88.25 in July and January.
B. $44 in July and January.
C. $88.25 in July.
D. $88 in July.

Blooms: Analyze
Difficulty: Medium

8. A bond with a 7% coupon that pays interest semi-annually and is priced at par will have a
market price of _____ and interest payments in the amount of _____ each.
A. $1,007; $70
B. $1,070; $35
C. $1,070; $70
D. $1,000; $35

Blooms: Analyze
Difficulty: Medium

6-3
9. Queen and Bees, Inc. offers a 7% coupon bond with semiannual payments and a yield to
maturity of 7.73%. The bonds mature in 9 years. What is the market price of a $1,000 face
value bond?
A. $953.28
B. $963.88
C. $1,108.16
D. $1,401.26
E. $1,401.86

Blooms: Analyze
Difficulty: Medium

10. Part of the Rock, Inc. has a 6% coupon bond that matures in 11 years. The bond pays
interest semiannually. What is the market price of a $1,000 face value bond if the yield to
maturity is 12.9%?
A. $434.59
B. $580.86
C. $600.34
D. $605.92
E. $947.87

Blooms: Analyze
Difficulty: Medium

11. Your firm offers a 10-year, zero coupon bond. The yield to maturity is 8.8%. What is the
current market price of a $1,000 face value bond?
A. $430.24
B. $473.26
C. $835.56
D. $919.12
E. $1,088.00

Blooms: Analyze
Difficulty: Medium

6-4
12. The zero coupon bonds of Quipta Inc. have a market price of $394.47, a face value of
$1,000, and a yield to maturity of 6.87%. How many years is it until this bond matures?
A. 7 years
B. 10 years
C. 14 years
D. 18 years
E. 21 years

Blooms: Analyze
Difficulty: Medium

13. If its yield to maturity is less than its coupon rate, a bond will sell at a ____, and increases
in market interest rates will ____.
A. discount; decrease this discount.
B. discount; increase this discount.
C. premium; decrease this premium.
D. premium; increase this premium.

Blooms: Remember
Difficulty: Medium
Topic: 06-03 Pure Discount Bonds

14. Zero-coupon bonds:
A. always sell at a discount before maturity.
B. always sell at a premium before maturity.
C. have no face value.
D. have no maturity.

Blooms: Remember
Difficulty: Easy

6-5
15. The value of a 20 year zero-coupon bond when the market required rate of return of 9%
(semi-annual) is:
A. $414.64.
B. $318.38.
C. $171.93.
D. $178.43.

Blooms: Analyze
Difficulty: Medium

16. A consol is selling at $1,200 with an interest rate of 5%. How much would this bond sell
for if the interest rate were 8% instead?
A. $200.
B. $750.
C. $1,650.
D. $1,920.

Blooms: Analyze
Difficulty: Medium

17. All else constant, a bond will sell at _____ when the yield to maturity is _____ the coupon
rate.
A. a premium; higher than
B. a premium; equal to
C. at par; higher than
D. a discount; higher than

Blooms: Remember
Difficulty: Medium

6-6
18. Which of the following amounts is closest to the value of a bond that pays $55
semiannually and has an effective semiannual interest rate of 5%? The face value is $1,000
and the bond matures in 3 years. There are exactly six months before the first interest
payment.
A. $1,014.
B. $1,055.
C. $888.
D. $1,025.
E. $1,000.

Blooms: Analyze
Difficulty: Medium

19. All else constant, a coupon bond that is selling at a premium, must have:
A. a coupon rate that is equal to the yield to maturity.
B. a market price that is less than par value.
C. semi-annual interest payments.
D. a yield to maturity that is less than the coupon rate.

Blooms: Remember
Difficulty: Medium

20. The newly issued bonds of the Cain Corp. offer a 6% coupon with semiannual interest
payments. The bonds are currently priced at par value. The effective annual rate provided by
these bonds must be:
A. equal to 3%.
B. greater than 3% but less than 4%.
C. equal to 6%.
D. greater than 6% but less than 7%.
E. equal to 12%.

Blooms: Analyze
Difficulty: Medium

6-7
21. A 12-year, 5% coupon bond pays interest annually. The bond has a face value of $1,000.
What is the percentage change in the price of this bond if the market yield rises to 6% from
the current yield of 4.5%?
A. 11.11% decrease
B. 12.38% decrease
C. 12.38% increase
D. 14.13% decrease
E. 14.13% increase

Blooms: Analyze
Difficulty: Hard

22. Jackson Central has a 6-year, 8% annual coupon bond with a $1,000 par value. Earls
Enterprises has a 12-year, 8% annual coupon bond with a $1,000 par value. Both bonds
currently have a yield to maturity of 6%. Which of the following statements are correct if the
market yield increases to 7%?
A. Both bonds would decrease in value by 4.61%.
B. The Earls bond will increase in value by $88.25.
C. The Jackson bond will increase in value by 4.61%.
D. The Earls bond will decrease in value by 7.56%.
E. The Earls bond will decrease in value by $50.68.

Blooms: Analyze
Difficulty: Hard

23. The value of common stock today depends on:

A. the expected future holding period and the discount rate.
B. the expected future dividends and the capital gains.
C. the expected future dividends, capital gains and the discount rate.
D. the expected future holding period and capital gains.

Blooms: Remember
Difficulty: Medium
Topic: 06-04 Level-Coupon Bonds

6-8
24. Weisbro and Sons common stock sells for $21 a share and pays an annual dividend that
increases by 5% annually. The market rate of return on this stock is 9%. What is the amount
of the last dividend paid by Weisbro and Sons?
A. $.77
B. $.80
C. $.84
D. $.87
E. $.88

Blooms: Analyze
Difficulty: Medium

25. The Double Dip Co. is expecting its ice cream sales to decline due to the increased interest
in healthy eating. Thus, the company has announced that it will be reducing its annual
dividend by 5% a year for the next two years. After that, it will maintain a constant dividend
of $1 a share. Two weeks ago, the company paid a dividend of $1.40 per share. What is this
stock worth if you require a 9% rate of return?
A. $10.86
B. $11.11
C. $11.64
D. $12.98
E. $14.23

Blooms: Analyze
Difficulty: Hard

6-9
26. Which of the following amounts is closest to what should be paid for Overland common
stock? Overland has just paid a dividend of $2.25. These dividends are expected to grow at a
rate of 5% in the foreseeable future. The required rate of return is 11%.
A. $20.45
B. $21.48
C. $37.50
D. $39.38
E. $47.70

Blooms: Analyze
Difficulty: Medium

27. The Felix Corp. projects to pay a dividend of $.75 next year and then have it grow at 12%
for the following 3 years before growing at 8% indefinitely thereafter. The equity has a
required return of 10% in the market. The price of the stock should be ___.
A. $9.38
B. $17.05
C. $41.67
D. $59.80
E. $62.38

Blooms: Analyze
Difficulty: Hard

6-10
28. A stock you are interested in paid a dividend of $1 last month. The anticipated growth rate
in dividends and earnings is 25% for the next 2 years before settling down to a constant 5%
growth rate. The discount rate is 12%. Calculate the expected price of the stock.
A. $15.38
B. $20.50
C. $21.05
D. $22.27
E. $26.14

Blooms: Analyze
Difficulty: Hard

29. The dividend growth rate is equal to the product of what two ratios?
A. ROA, current ratio.
B. ROE, retention ratio.
C. PM, ROA.
D. ROA, ROE.

Blooms: Remember
Difficulty: Easy
Topic: 06-05 Consols

30. Which of the following values is closest to the amount that should be paid for a stock that
will pay a dividend of $10 one year from now and $11 two years from now? The stock will be
sold in 2 years for an estimated price of $120. The appropriate discount rate is 9%.
A. $114.
B. $119.
C. $124.
D. $129.
E. $138.

Blooms: Analyze
Difficulty: Medium

6-11
31. Which of the following amounts is closest to what should be paid for Overland common
stock? Overland has just paid a dividend of $2.25. These dividends are expected to grow at a
rate of 5% in the foreseeable future. The risk of this company suggests that future cash flows
should be discounted at a rate of 11%.
A. $39.38
B. $37.50
C. $21.48
D. $20.45

Blooms: Analyze
Difficulty: Medium

32. What would be the maximum an investor should pay for the common stock of a firm that
has no growth opportunities but pays a dividend of $1.36 per year? The next dividend will be
paid in exactly 1 year. The required rate of return is 12.5%.
A. $17.00
B. $9.52
C. $10.88
D. $12.24

Blooms: Analyze
Difficulty: Easy

33. Mortgage Instruments Inc. is expected to pay dividends of $1.03 next year. The company
just paid dividends of $1. This growth rate is expected to continue. How much should be paid
for Mortgage Instruments stock just after the dividend if the appropriate discount rate is 5%?
A. $20.
B. $21.
C. $34.
D. $52.

Blooms: Analyze
Difficulty: Medium

6-12
34. S&P Inc. common stock sells for $39.86 a share at a market rate of return of 9.5%. The
company just paid its annual dividend of $1.20. What is the rate of growth of its dividend?
A. 5.2%
B. 5.5%
C. 5.9%
D. 6.0%
E. 6.3%

Blooms: Analyze
Difficulty: Medium

35. If a company is currently paying $.40 in dividends and they are expected to grow at 7%
for the next 6 years and then grow at 4% thereafter the dividend expected in year 8 is:
A. $4.33.
B. $0.65.
C. $4.39.
D. $0.69.
E. $0.67.

Blooms: Analyze
Difficulty: Medium

6-13
36. The Bell Weather Co. is a new firm in a rapidly growing industry. The company is
planning on increasing its annual dividend by 20% a year for the next four years and then
decreasing the growth rate to 5% per year. The company just paid its annual dividend in the
amount of $1.00 per share. What is the current value of one share if the required rate of return
is 9.25%?
A. $35.63
B. $38.19
C. $41.05
D. $43.19
E. $45.81

Blooms: Analyze
Difficulty: Hard

37. Zeta Corporation has issued a $1,000 face value zero-coupon bond. Which of the
following values is closest to the correct price for the bond if the appropriate discount rate is
4% and the bond matures in 8 years?
A. $968.
B. $731.
C. $1,000.
D. $1,125.

Blooms: Analyze
Difficulty: Medium

38. The No-zip Snap Company had net earnings of $127,000 this past year. Dividends were
paid of $38,100 on the company's equity of $1,587,500. The estimated growth for No-Zip is:
A. 2.4%
B. 5.6%
C. 7.2%
D. 16.8%

Blooms: Analyze
Difficulty: Medium

6-14
39. The No-zip Snap Company had net earnings of $127,000 this past year. Dividends were
paid of $38,100 on the company's equity of $1,587,500. If No-Zip has 100,000 shares
outstanding with a current market price of $11 5/8 per share, what is the required rate of
return?
A. 9%
B. 6%
C. 4.2%
D. 14%

Blooms: Analyze
Difficulty: Medium

40. Martha's Vineyard recently paid a $3.60 annual dividend on its common stock. This
dividend increases at an average rate of 3.5% per year. The stock is currently selling for
$62.10 a share. What is the market rate of return?
A. 2.5%
B. 3.5%
C. 5.5%
D. 6.0%
E. 9.5%

Blooms: Analyze
Difficulty: Medium

41. The discount rate in equity valuation is composed entirely of:

A. the dividends paid and the capital gains yield.
B. the dividend yield and the growth rate.
C. the dividends paid and the growth rate.
D. the capital gains earned and the growth rate.
E. the capital gains earned and the dividends paid.

Blooms: Remember
Difficulty: Medium

6-15
42. Shares of common stock of the Samson Inc. offer an expected total return of 12%. The
dividend is increasing at a constant 8% per year. The dividend yield must be:
A. -4%.
B. 4%.
C. 8%.
D. 12%.
E. 20%.

Blooms: Analyze
Difficulty: Medium

43. Assume that you are using the dividend growth model to value stocks. If you expect the
market rate of return to increase across the board on all equity securities, then you should also
expect the:
A. market values of all stocks to increase, all else constant.
B. market values of all stocks to remain constant as the dividend growth will offset the
increase in the market rate.
C. market values of all stocks to decrease, all else constant.
D. stocks that do not pay dividends to decrease in price while the dividend-paying stocks
maintain a constant price.
E. dividend growth rates to increase to offset this change.

Blooms: Understand
Difficulty: Medium

6-16
44. A corporate bond with a face value of $1,000 matures in 4 years and has an 8% coupon
paid at the end of each year. The current price of the bond is $932. What is the yield to
maturity for this bond?
A. 5.05%.
B. 8.58%.
C. 10.15%.
D. 11.92%.
E. 6.48%.

Blooms: Analyze
Difficulty: Medium

45. Angelina's made two announcements concerning its common stock today. First, the
company announced that its next annual dividend has been set at $2.16 a share. Secondly, the
company announced that all future dividends will increase by 4% annually. What is the
maximum amount you should pay to purchase a share of Angelina's stock if your goal is to
earn a 10% rate of return?
A. $21.60
B. $22.46
C. $27.44
D. $34.62
E. $36.00

Blooms: Analyze
Difficulty: Easy

6-17
46. ABC Imports paid a $1.00 per share annual dividend last week. Dividends are expected to
increase by 5% annually. What is one share of this stock worth to you today if the appropriate
discount rate is 14%?
A. $7.14
B. $7.50
C. $11.11
D. $11.67
E. $12.25

Blooms: Analyze
Difficulty: Easy

47. The common stock of Eddie's Engines Corp. sells for $25.71 a share. The stock is
expected to pay $1.80 per share next month when the annual dividend is distributed. Eddie's
has established a pattern of increasing its dividends by 4% annually and expects to continue
doing so. What is the market rate of return on this stock?
A. 7%
B. 9%
C. 11%
D. 13%
E. 15%

Blooms: Analyze
Difficulty: Medium

6-18
48. LCP, a newly formed medical group, is currently paying dividends of $.50. These
dividends are expected to grow at a 20% rate for the next 5 years and at a 3% rate thereafter.
What is the value of the stock if the appropriate discount rate is 12%?
A. $8.08.
B. $11.17.
C. $14.22.
D. $17.32.
E. $30.90.

Blooms: Analyze
Difficulty: Hard

49. The discount rate can be thought of as the sum of what two parts?
A. ROE, retention ratio.
B. Dividend yield, growth rate in dividends.
C. Price, growth rate in dividends.
D. Dividend yield, price.
E. ROA, ROE.

Blooms: Remember
Difficulty: Medium

50. A firm's value increases when it invests in projects that have:

A. a rate of return less than the discount rate.
B. a rate of return equal to the discount rate.
C. a rate of return greater than the discount rate.
D. a rate of return equal to or less than the discount rate.

Blooms: Understand
Difficulty: Easy
Topic: 06-06 Bond Concepts

6-19
51. A firm is known as a 'Cash Cow':

A. because it has several good growth opportunities.
B. because it pays out all of its non-growing earnings.
C. because dividends are growing at a rapid rate.
D. because the discount rate is extremely low.

Blooms: Understand
Difficulty: Easy
Topic: 06-07 Interest Rates and Bond Prices

52. The P/E ratio is a multiple of earnings that investors pay for a stock. The P/E is
__________ related to growth, __________ related to the discount rate, and __________
related to the stock's risk.
A. positively; positively; negatively.
B. negatively; positively; positively.
C. positively; negatively; negatively.
D. negatively; negatively; positively.

Blooms: Remember
Difficulty: Hard

53. Firms with higher expected growth opportunities usually sell for:

A. a lower price earnings multiple.
B. the same price earnings multiple for all firms.
C. a higher price earnings multiple.
D. a price that depends on the payout ratio only.
E. a price independent of the P/E.

Blooms: Remember
Difficulty: Easy

6-20
54. The average Japanese P/E ratio was reported as between 40 and 100 in recent years while
the average U.S. P/E ratio was 25. The reason for the higher Japanese P/E ratio has been
partially explained by:
A. growth opportunities over stated earnings.
B. understated earnings and low interest rates.
C. overstated earnings and low interest rates.
D. understated earnings and overstated growth opportunities.
E. low interest rates and greater growth opportunities.

Blooms: Remember
Difficulty: Medium
Topic: 06-08 Yield to Maturity

55. Stand Still Co. has been earning $1 per share on 400,000 shares, and paying out all of the
earnings. The discount rate for a company of this risk is 10%. The company has an investment
opportunity with a cost of $1,500,000 and expects to earn $230,000 after taxes, but they must
reinvest 35% of these earnings to continue to maintain the expansion in earnings. What is the
value of the company without the investment and what is the value with the investment?
A. $200,000; $1,500,000
B. $4,000,000; $6,600,000
C. $4,000,000; $3,995,000
D. $400,000; $15,000,000

Blooms: Analyze
Difficulty: Hard

56. The net present value of a growth opportunity, NPVGO, can be defined as:
A. the present value of an investment in one new project.
B. the steady growth in dividends from continual re-investment with positive NPV.
C. continual reinvestment of earnings when r < g.
D. a single period investment when r > g.

Blooms: Remember
Difficulty: Medium

6-21
57. If the quoted dividend yield in the paper was 2.2% and the dividend was listed as $0.72
what price is used in the calculation of dividend yield?
A. the day open of $32.15.
B. the day low of $32.
C. the day close of $32.73.
D. the day high of $33.50.

Blooms: Analyze
Difficulty: Medium

58. The closing price of a stock is quoted at 22.87, with a P/E of 26 and a net change of 1.42.
Based on this information, which one of the following statements is correct?
A. The closing price on the previous day was $1.42 higher than today's closing price.
B. A dealer will buy the stock at $22.87 and sell it at $26 a share.
C. The stock increased in value between yesterday's close and today's close by $.0142.
D. The earnings per share are equal to 1/26th of $22.87.
E. The earnings per share have increased by $1.42 this year.

Blooms: Analyze
Difficulty: Medium
Topic: 06-10 Holding-Period Return

59. Spot rates are the interest rates that prevail in the market from:
A. the current period until the sale of the security.
B. time zero until the asset's maturity.
C. one period forward to maturity.
D. some unknown future period.

Blooms: Remember
Difficulty: Medium

6-22
60. The term structure can be described as the:

A. relationship of spot rates of interest and bond prices.
B. relationship of coupon rates and money rates.
C. relationship of spot rates of interest and maturity.
D. relationship of coupon rates and maturity.

Blooms: Remember
Difficulty: Medium

61. Which of the following statements is true?

A. The spot rate is a weighted average of the yields to maturity.
B. The spot rate is always higher than the yield to maturity.
C. The yield to maturity is a weighted average of spot rates.
D. The yield to maturity is always higher than the spot rate.

Blooms: Remember
Difficulty: Easy

62. A forward rate prevailing from period three through to period four can be:
A. readily observed in the market place.
B. extracted from high coupon bonds.
C. extracted from spot rates with 2 and 3 year maturities.
D. extracted from spot rates with 3 and 4 years to maturity.

Blooms: Remember
Difficulty: Hard

6-23
63. The expectations hypothesis states that the forward rate over second period is:
A. set to the spot rate expected to prevail over the second period.
B. equal to the first period spot rate.
C. always greater than the spot rate in period one.
D. always greater than the period 3 forward rate.

Blooms: Remember
Difficulty: Medium

64. Term structure refers to:

A. how interest rates vary over different structures of bonds.
B. how interest rates vary over different structures of corporate securities.
C. how interest rates vary over time with otherwise identical bonds.
D. the maturity dates of a bond issue.

Blooms: Remember
Difficulty: Easy

65. Which of the following amounts is closest to the present value of a bond with coupon
payment of $80 and a face value of $1,000? Interest payments are made at the end of each of
2 years, and the bond matures in 2 years. The spot interest rate for the first year is 10%, and
the spot interest rate for the second year is 12%.
A. $910
B. $934
C. $949
D. $1,000

Blooms: Analyze
Difficulty: Medium

6-24
66. What can you deduce about forward rates of interest if the liquidity-preference hypothesis
of the term structure is correct?
A. The forward rate is less than investor's expectations of next year's one-year interest rate.
B. The forward rate is greater than investor's expectations of next year's one-year interest rate.
C. The forward rate is equal to investor's expectations of next year's one-year interest rate.
D. The forward rate is equal to the risk-free interest rate.

Blooms: Understand
Difficulty: Hard

67. Given r1 = .050 and r2 = .054, what can you deduce about investor's expectations of future
short-term interest rates if the expectations hypothesis is correct?
A. Investors expect future short-term rates to be greater than current short-term rates.
B. Investors expect future short-term rates to be less than current short-term rates.
C. Investors expect future short-term rates to be equal to current short-term rates.
D. Investors expect future short-term rates to be higher than current forward rates.

Blooms: Understand
Difficulty: Medium

68. The market rate of interest on 2 year bonds is 6.25% while the rate on a one year bond
maturing on one year is 5.50%. The forward rate on a one year bond one year from now is
6.5%. The liquidity premium to induce investors to hold the 2 year bond is:
A. 0.250%.
B. 0.005%.
C. 0.125%.
D. 0.500%.

Blooms: Analyze
Difficulty: Hard

6-25
69. Suppose that a bond that will mature in three years is now traded at $99.83. The annual
coupon payment is $5.635. Its yield to maturity is
A. 3.42%.
B. 5.10%.
C. 5.69%.
D. 7.20%.

Blooms: Analyze
Difficulty: Easy

70. The liquidity preference hypothesis explains that the 2nd year forward rates are set higher
than the expected spot rate over year two because:
A. of a downward sloping yield curve.
B. of long term rates being greater than short term rates.
C. investors must be induced to buy the riskier two-year bond.
D. two year bonds are less risk than one year's bonds when rates are higher.

Blooms: Understand
Difficulty: Medium

71. Suppose that an investor disagrees with market expectations and feels that the forward rate
prevailing in the market is higher than what it should be, then the investor can make profit
by:
A. selling a bond now and buying it up later.
B. selling a bond now.
C. buying a bond now.
D. buying a bond now and selling it later.

Blooms: Understand
Difficulty: Hard

6-26
72. Suppose that a bond that will mature in two years has a face value of $1000 and 20%
coupon rate. The one year spot market interest rate is 13% and the expected second period's
forward rate is 12%. According to the expectation hypothesis, the two year spot rate is:
A. 11.50%.
B. 9.12%.
C. 12.74%.
D. 7.00%.

Blooms: Analyze
Difficulty: Medium

73. In the above example, the price of the bond is

A. $1121.
B. $1000.
C. $1325.
D. $1200.

Blooms: Analyze
Difficulty: Easy

74. Suppose that there are three zero coupon bonds with maturity date 1 year, 2 year and 3
year respectively. The current price of the 1 year, 2 year and 3 year bonds respectively are
$826.45, $718.18 and $640.66 respectively. The yield to maturity of the first year bond is:
A. 21%.
B. 18%.
C. 12%.
D. 11%.

Blooms: Analyze
Difficulty: Medium

6-27
75. In the above problem, the yield to maturity of the 2 year bond is:
A. 21%.
B. 18%.
C. 12%.
D. 11%.

Blooms: Analyze
Difficulty: Medium

Short Answer Questions

76. A number of publicly traded firms pay no dividends yet investors are willing to buy shares
in these firms. How is this possible? Does this violate our basic principle of stock valuation?
Explain.
Our basic principle of stock valuation is that the value of a share of stock is simply equal to
the present value of all of the expected dividends on the stock. According to the dividend
growth model, an asset that has no expected cash flows has a value of zero, so if investors are
willing to purchase shares of stock in firms that pay no dividends, they evidently expect that
the firms will begin paying dividends at some point in the future.

Blooms: Understand
Difficulty: Hard

77. Calculate the YTM on a bond priced at $1,036 which has 2 years to maturity, a 10%
coupon rate, and a return of $1,000 at maturity.
$1.036 = 100/(1 + YTM)1 + 1,100/(1 + YTM)2? YTM = 8%.

Blooms: Analyze
Difficulty: Easy

6-28
78. Given the opportunity to invest in one of the three bonds listed below, which would you
purchase? Assume an interest rate of 7%.
Bond Face Value Annual Coupon Rate Maturity Price

A $1,000 4% 1 year $990
B $1,000 7.5% 17 years $990
C $1,000 8.5% 25 years $990
PV of Bond A = $971.96 < Price Do not buy YTM (5.05)

PV of Bond B = $1048.82 > Price Buy YTM (7.61)
PV of Bond C = $1,174.80 > Price Buy YTM (8.6)

Blooms: Analyze
Difficulty: Medium

79. Show that a firm with earnings of $10,000 a year in perpetuity would be better off paying
all earnings in dividends rather than investing 25% of its earnings (also in perpetuity) in
projects earning 14% if its discount rate is 15%.
All as dividends: Value = $10,000/.15 = $66,667

Investment: Value = $7,500/.15 + (-2,500 + 2,850/1.15)/.15 = $50,000 - 144.93 = $49,855.07

Blooms: Analyze
Difficulty: Hard

6-29
80. Given the following set of spot rates:
Year Spot Rate

1 .050
2 .054
3 .059
4 .066
Calculate the 1-year forward rates over each of the next 3 years.
1-year forward rate next year: 1.0542/1.050 = 1.058

1-year forward rate in 2 years: 1.0593/1.0542 = 1.069
1-year forward rate in 3 years: 1.0664/1,9583 = 1.087

Blooms: Analyze
Difficulty: Hard

81. Explain why some bond investors are subject to liquidity risk and/or default risk. How
does each of these risks affect the yield of a bond?
Liquidity problems exist in thinly traded bonds making some bonds difficult to sell at their
actual value. Default risk is the likelihood the corporation will default on its bond obligations.
If either (or both) of these risks exist, investors will require compensation by demanding a
high yield.

Blooms: Understand
Difficulty: Hard

6-30
82. Define what is meant by interest rate risk. Assume you are the manager of a $100 million
portfolio of corporate bonds and you believe interest rates will fall. What adjustments should
you make to your portfolio based on your beliefs?
Interest rate risk is the risk that arises for bond owners from fluctuating interest rates. All else
the same, if interest rates are expected to fall you should purchase long-term bonds and/or low
coupon bonds, and sell shorter-term, higher-coupon bonds.

Blooms: Understand
Difficulty: Hard

6-31

Multiple Choice Questions: How To Value Bonds and Stocks

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Multiple Choice Questions: How To Value Bonds and Stocks

Uploaded by

Copyright:

Available Formats

Chapter 06 - How to Value Bonds and Stocks

Multiple Choice Questions

1. A pure discount bond:

Accessibility: Keyboard Navigation

2. A level coupon bond:

Accessibility: Keyboard Navigation

3. The coupon of a bond is:

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

23. The value of common stock today depends on:

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

41. The discount rate in equity valuation is composed entirely of:

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

50. A firm's value increases when it invests in projects that have:

Accessibility: Keyboard Navigation

51. A firm is known as a 'Cash Cow':

Accessibility: Keyboard Navigation

Accessibility: Keyboard Navigation

53. Firms with higher expected growth opportunities usually sell for: